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Digitalisation

Pros and cons: virtual money

by Chris-Oliver Schickentanz

Opinion

Facebook aims to revolutionise the cryptocurrency market with its new virtual currency Libra.

Facebook aims to revolutionise the cryptocurrency market with its new virtual currency Libra.

Cryptocurrencies sound like a good idea. They are not controlled by a small number of central bankers, they are universal, and the supply of monetary units cannot be arbitrarily increased. Facebook is even working on its own virtual currency. Sadly, the brave new digital world has considerable downsides – especially for developing countries.

There are nearly 2,000 different cryptocurrencies in the world today. Most of them lead a shadowy existence. On average, their accumulated market value is less than 1 million dollars. Others, however, have reached two to three-digit billion figures. Bitcoin and ripple are examples.

All digital currencies have in common that:

  • they are not issued by a single state or central bank,
  • they are purely virtual (no bank notes, no coins) and
  • they claim to be paragons of transparency and traceability.

This is possible thanks to so-called block-chain technology (see Piet Kleffmann, D+C/E+Z e-Paper 2019/10, Focus section).

The big question is whether virtual currencies are actually money. According to economists, money serves three basic functions:

  • as a means of exchange and payment,
  • as a unit of accounting and
  • as an instrument for storing value.

The euro and the dollar obviously meet these criteria. What about cryptocurrencies?

Yes, they can be used as units of account. After all, they are mostly traded 24 hours a day and thus almost always have a reference rate. However, it is much harder to see them as storing value. The reason is that they are much more volatile than conventional currencies. The bitcoin price, for example, has fluctuated between $ 3,400 and $ 13,400 in the course of this year alone. That range hardly suggests a stable store of value. Unfortunately, moreover, cryptocurrencies are also not safe from criminals. They can be hacked and thus stolen. Finally, it is doubtful whether cryptocurrencies deserve to be regarded as a means of exchange. Even on the internet, they rarely appear when websites list payment options. Dramatic price swings are a cause of concern. All summed up, replacing physical money is still a distant dream.

Facebook is the world’s most important social-media platform with more than 2 billion active users. It could well revolutionise the world of digital currencies in coming months. The corporation is planning to introduce a virtual currency of its own. It will be called Libra and have a number of advantages over the cryptocurrencies we know so far. For one thing, it will be backed by a basket of established currencies such as the dollar and euro, so fluctuations in value will be far less marked than in the case of bitcoin, for instance. though the credit card giants Visa and Mastercard have withdrawn again, and so has Ebay, the digital marketplace. What matters most, however, is probably Facebook’s huge market power, which must not be underestimated and is likely to prove very helpful, especially in many African and Asian countries.

Demand for cryptocurrencies tends to be high in developing countries, especially in places where a combination of soaring prices and political instability fuel mistrust in national currencies. Countries like Venezuela, Zimbabwe, Sudan and Liberia, for example, are beset by hyperinflation. Therefore, foreign currencies – especially the dollar – are used commonly. Smartphone penetration is high, moreover, so the preconditions for relying on digital currencies are in place. Libra could indeed find very fertile soil in such places.

Sadly, the cryptocurrencies that are currently in operation have a dark side for developing countries. In many of them, people try to earn money by cryptocurrency “mining”. Put simply, this involves performing computing services for a virtual currency issuer and being paid in that currency. The problem is that currency mining is a very resource-intensive activity. It requires modern IT equipment and, above all, lots of electric power. The implication is that important resources, that would be better used for education purposes or growing small-scale businesses, are being diverted.


Chris-Oliver Schickentanz is chief investment officer of Commerzbank in Frankfurt.
[email protected]

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